Right or wrong – tenants may not have as much leverage as they think

Writer debut

Justin Bedecarré is an Associate at Cushman & Wakefield one of the most well known commercial real estate firms, working in downtown San Francisco in one of the top producing offices in Northern California. Justin has an impressive roll of tenants he has represented including Citigroup, Sony Music, Wells Fargo, Bank of America, and Hearst Corporation to name a few.

Justin is respected for breaking the boundaries of traditional commercial real estate and was awarded “Rookie of the Year” for C&W. He studied economics and political science at the University of California, Berkeley and previously worked with the Home Builders Association of Northern California. Justin is an up and comer in the industry and is one to watch. We proudly welcome him to Agent Genius and ask you to welcome him in comments!

Leasing makes the world go ’round

Leasing makes the world go ’round (at least the commercial real estate world). Especially in a severe downturn, owners (whether institutional or otherwise) are going “back to the basics.” This means investing in leasing. In this time honored tradition, the battle of tenants versus landlords rages on. Each side tries to gain the upper hand in every negotiation. Leverage can be obfuscated as the economy emerges from a great recession.

Most people presume leverage has shifted to tenants in today’s market. Unemployment is 9+% nationally, and by some estimates will remain at this levels through 2011. Approximately $350 million in commercial loans will mature annually for the next 3-5 years. The commercial real estate business lags the bottom of the stock market and overall economy by several quarters historically. There seems to be a lot more ammunition for tenants to continue suppressing rents and demanding concessions.

However, this isn’t the case everywhere. There are a lot of mixed messages for companies. Frankly, there is a lot of confusion in the brokerage community as well. I am going to wear my tenant broker hat and show why that is and how to overcome it.

How to overcome

Some sectors of commercial real estate markets are tightening up. There has been a flight to quality as rents dropped, so companies capitalized on the opportunity to upgrade their image with higher quality space. Companies have shrunk and start-ups have been created, so the spaces for under 15,000 sf have become more competitive than before. Technology companies including social media and cloud computing are emerging with velocity and the larger tech firms are getting larger.

These trends create competition among a specific type of office space. Surprisingly in this market, for some tenants, it will be hard to find space and Landlords will be obstinate on pricing. When a Landlord says they have the only space in town like it, tell them that your client doesn’t need it. The point is to not throw your arms in the air and give in to the high rates or gripe about their irrational rent expectations. Rather, be more flexible to look at alternatives. Companies are more amenable to change than you think.

It is pivotal to understand the complexities of leasing and how the macro economic factors affect the cre market. Companies see that unemployment is high, buildings are being foreclosed, the market is at the bottom. They do not see vacancy rates in Class A vs Class B, view space analysis, or sub-market differentials.

You can explain why a 5,000 square foot creative user cannot find space that they originally envisioned, or why a large law firm may need $150 in tenant improvements and the Landlord just can’t fund it. The major factors that have both saved the commercial real estate market and also kept the Landlords optimistic was the supply constraint (in most markets across the US). Granted, the sublease space that is perpetually coming to the market adds supply and dilutes demand, but the space has to be a specific fit for a company to absorb it.

Brokers are over promising

Too many brokers are over promising, and we have to recognize that companies rely on us for education as much as negotiation. The major markets are mounting a comeback in some sectors but still reeling in others. Whether you represent an international, institutional client or a small local company, the specific market expertise of the cre market play an equally crucial role in the successful management of a real estate portfolio or a one-time transaction. I represent both sides of the spectrum of tenants, and market assumptions need to be met abruptly with real estate expertise and some empathy.

Capricious claims of higher rents and strong market conditions should not be supported with capitulation, unless they are justified by exhausting all alternatives. Companies need to be more creative or better apprised of what to expect, and willing to do something different. Maybe then the once highly demanded feature of a building will become less desirable and more affordable, or maybe the next group will swoop right in and pay the higher rents. All the while, you save your client $100,000 annually on a 10,000 square foot space and they get to invest in more human capital. Now you have played a part in growing the economy while helping your client with their bottom-line and keeping their brand intact.

Justin Bedecarré is a broker at Cushman & Wakefield in downtown San Francisco representing local and multi-market tenants including Wells Fargo, Marsh & McLennan, Gensler and Broadcom. He is also a blogger and co-founder of the Bay Area Commercial Real Estate Blog (www.bayareacomre.wordpress.com), UC Berkeley alum, avid Cal football fan and fifth generation San Franciscan.

Justin, glad to see you on AG bringing perspective to our niche of tenant representation. Managing client expectations regarding what is feasible in the marketplace is always important. With so much negative press regarding the economy, sometimes the perception is market fundamentals are worse than reality. Houston is a good example where negative absorption is less than most major markets and quoted rents are only off about 8% over the last year. There is certainly a bigger spread between and asking rates and where deals are getting signed and Landlords are certainly more aggressive with concessions to attract and retain tenants…..but they are not giving away the farm.

It depends on what market you are in. Feel free to give me a call or email and we can discuss. It San Francisco, the smaller spaces are being absorbed by start-ups and tech clients, so it is much more competitive which drives up prices. Thanks for the welcome note and comment. I look forward to talking with you!

Duke, Erica and Jonathan, Thanks for the comments! I look forward to many more postes and conversations!

Erica, that is the big risk for Landlords. We have seen them take big risks turning down deals in hopes of a better market. We will see if it pays off, but sometimes a bird in the hand is better than two in the bushes.

Thanks for your comment. We have seen large slides in rent over the past year but have slowed their downfall, and the ask and take rates have been closing, which helps manage expectations. Landlords are still offering free rent to keep the “face rates” high, but the competition I discuss in this article is contained in a few office types and economic sectors. In these spaces/buildings, some brokers have promised 10-15% rent hikes, which we think is unwarrented. But when it makes the paper, it must be true! Look forward to hearing from you soon, Coy.

#CRE | Great article, Justin! – first of many I’m sure. Kudos to AgentGenius and Cushman & Wakefield for their respective parts in making it happen. I look forward to being involved in future feedback surrounding your perspectives!

Thanks for your comment and I look forward to collaborating with you. Agent Genius has a lot of potential in the CRE world, and I am glad to be along for the ride and help get it to the next level. Stay tuned…

Commercial real estate outlook is positive

According to the National Association of Realtors’ (NAR) quarterly forecast, commercial real estate is continuing to improve, but the pace is slowing.

Dr. Lawrence Yun, NAR chief economist, said that fundamentals are still on an uptrend. “Growth in commercial real estate sectors continues at a moderate pace from a very slow pace of absorption, despite job additions to the economy. Companies appear hesitant to add new space,” he said.

“Office demand is expected to see only slow and gradual improvement,” Dr. Yun added. “Demand for retail space is benefiting from improved household wealth, while industrial real estate is stable with increasing international trade, which requires warehouse space. Of course, the apartment market fundamentals are the strongest, as nearly all of the new household formation in the past 10 years has come from renters, and not homeowners.”

Forecasting the future

Overall, national vacancy rates in the coming year are forecast to drop 0.2 percentage point in the office sector (the sector with the worst vacancy rates) to 15.6 percent in the first quarter of 2015.

Vacancy rates are projected to fall 0.1 point in industrial to 8.9 percent, and 0.3 point for retail real estate to 9.9 percent.

With rising apartment construction, the average multifamily vacancy rate will edge up 0.1 percent to 4.1 percent, but this sector continues to experience the tightest availability and strongest rent growth of all the commercial sectors.

Rental rates for various sectors

Office rents are projected to increase 2.3 percent in 2014 and 3.2 percent next year. Net absorption of office space in the U.S., which includes the leasing of new space coming on the market as well as space in existing properties, is likely to total 44.6 million square feet this year and 50.0 million in 2015.

Annual industrial rents should rise 2.4 percent this year and 2.6 percent in 2015. Net absorption of industrial space nationally is seen at 106.1 million square feet in 2014 and 110.6 million next year.

Average retail rents are forecast to rise 2.0 percent in 2014 and 2.3 percent next year. Net absorption of retail space is likely to total 14.6 million square feet this year and 20.9 million in 2015.

Average apartment rents are projected to rise 4.3 percent this year and 3.5 percent in 2015. Multifamily net absorption is expected to total 204,900 units in 2014 and 112,500 next year.

Regional performance varies

The markets with the lowest office vacancy rates in the first quarter are New York City, with a vacancy rate of 9.5 percent; Washington, D.C., at 10.2 percent; Little Rock, Ark., 11.6 percent; Birmingham, Ala., 12.7 percent; and San Francisco and Nashville, Tenn., at 12.8 percent each.

The areas with the lowest industrial vacancy rates currently are Orange County, Calif., with a vacancy rate of 3.7 percent; Los Angeles, 3.8 percent; Miami, 5.8 percent; Seattle at 5.9 percent; and San Riverside/Bernardino, Calif., at 6.1 percent.

Markets with the lowest retail vacancy rates include San Francisco, at 3.1 percent; Fairfield County, Conn., 3.8 percent; Long Island, N.Y., 4.8 percent; San Jose, Calif., 5.2 percent; and Northern New Jersey and Orange County, Calif., at 5.3 percent each.

Areas with the lowest multifamily vacancy rates currently are New Haven, Conn., at 2.1 percent; Minneapolis and New York City, 2.3 percent; and Oakland-East Bay, Calif., and San Diego, at 2.5 percent each.

Should you buy or lease office space? 5 questions to consider

Should you buy or lease an office space?

Many people set up shop and lease office space, assuming this is their best, and often only option, but there are some instances where buying office space is a better option. Many blindly make this decision based on a gut feeling, and we’re not saying that is a bad thing, we’re saying that in addition to that instinct, these five questions should be asked when considering whether you should lease or buy an office space.

1. Is your business well-established?

If your business is still in the startup phase, I rarely recommend buying. During the next 5 to 10 years you’ll experience employee count fluctuations, client and customer oscillations and even business direction and strategy adjustments. That is, you’ll need to be flexible, not tied to a certain space. Additionally, any leftover capital should most likely be recycled back into your budding startup. You don’t want to stretch yourself too thin.

The only exception that applies some of the time — not every time — is if your startup is in the technology space. Oftentimes tech employees can work remotely, or the technology is automated and won’t require more employees in the future. Additionally, clients of many tech startups can successfully access the company’s offering without visiting a physical office space.

2. Will you endanger your business with a property purchase?

Yes, buying can be a great investment and add a source of revenue, but even well-established business owners need to think about the stress that buying a property can put on their bottom line. Oftentimes your time and money is best spent on what you do best, running your enterprise. If buying means you won’t be able to focus essential resources to your first priority, your business, then you might want to hold off on buying.

Further, because commercial real estate can be a great investment, business owners are sometimes so eager to get in the game that they sell off portions of their business to finance the purchase. This is a bad idea. You should not let real estate decisions determine how you run your business. You’ve worked long and hard to build a successful company — don’t give it away. Another deal with always come along.

3. Do you have heavy, difficult-to-move equipment?

If you have machinery or specialized equipment that make it difficult for you to move, buying may be a great option for you. Two primary reasons: 1.) Lugging dense equipment from leased space to leased space is annoying, cumbersome and costly.

Plus, you increase the chances of damaging it every time you move. 2.) When a landlord knows it’s difficult for you to relocate, he or she is holding the cards when it’s time to renew your lease. If your lease doesn’t have a stipulation to remediate this, leasing office space will cost you more money than it should. More often than not, buying a custom space for your specialized equipment is the way to go.

4. Does your location affect employees or clients?

If attracting and maintaining top-notch employees means securing office space in your city’s prime business district, finding the perfect space to buy may be difficult. Why? Prime business districts usually have lower vacancy rates, which typically means higher prices plus fewer properties to choose from. Anytime you’re limited to a narrow location, you risk not landing the best deal. This doesn’t mean don’t buy, just understand what you’re up against from the onset.

The other issue you may face in buying location-specific space is when your customers or clients depend on your position for convenience. This is a challenge when and if your city’s submarkets are in transition. The trendy spot of the last five years, may not be in vogue five years from now. A lease allows flexibility to move where your customer and clients need you to be.

5. Are you prepared to be a landlord?

There’s a lot of maintenance that goes along with owning a building. Will you have the ability to hire a maintenance crew or will you tend the bathrooms, burnt out light bulbs and overflowing trash bins yourself?

Furthermore, many landlords have easy access to financing that could benefit you in the form of a tenant improvement package. Even though you may have capital to buy your building, can you afford to build it out the way you want to? The cost of ownership is sometimes underestimated. Make sure you’ve considered all of the possible expenses that go along with buying your office space.

Commercial real estate improving modestly, little change to come

Commercial real estate sector is improving

According to the National Association of Realtors’ (NAR) quarterly commercial real estate forecast, commercial real estate is improving modestly, with little change seen for the near future. Dr. Lawrence Yun, NAR’s Chief Economist said in a statement, “Jobs are the key driver for commercial real estate, and the accumulation of 7 million net new jobs from the low point a few years ago is steadily showing up as demand for leasing and purchases of properties,” he said. “But the difficulty of accessing loans remains a hindrance to a faster recovery.”

NAR reports that leasing activity rose 2.0 percent in the third quarter compared to the second, and sales levels are higher than a year ago.

Yun said there have been some shifts in commercial purchases. “Investors have been looking for better yields, and have found good potential in smaller commercial properties, notably in secondary and tertiary markets. Sales of commercial properties costing less than $2.5 million in the third quarter were 11 percent above a year ago, while prices for smaller properties were 4 percent above the third quarter of 2012.”

Commercial investment in properties costing more than $2.5 million rose 26 percent from a year ago, while prices for large properties were 9 percent above the third quarter of 2012.

National vacancy rates over the coming year are forecast to decline 0.2 percentage point in the office market, 0.6 point in industrial, and 0.5 point for retail real estate. The average multifamily vacancy rate will edge up 0.1 percent, but that sector continues to see the tightest availability and biggest rent increases.

Retail vacancy rates should be going down

Retail vacancy rates are forecast to decline from 10.4 percent in the fourth quarter of this year to 9.9 percent in the fourth quarter of 2014. Average retail rents should increase 1.4 percent in 2013 and 2.2 percent next year. Net absorption of retail space is projected at 11.0 million square feet in 2013 and 18.1 million next year.

Multifamily construction will meet demand

Multifamily Markets
The apartment rental market – multifamily housing – is likely to see vacancy rates edge up 0.1 percentage point from 3.9 percent in the fourth quarter to 4.0 percent in the fourth quarter of 2014, with new construction helping to meet higher demand. Average apartment rents are forecast to rise 4.0 percent this year and 4.3 percent in 2014. Multifamily net absorption is projected to total 239,400 units in 2013 and 211,300 next year.

Office rents should be going up

Vacancy rates in the office sector are expected to decline from a projected 15.6 percent in the fourth quarter to 15.4 percent in the fourth quarter of 2014. Office rents should increase 2.4 percent this year and 2.5 percent in 2014. Net absorption of office space in the U.S., which includes the leasing of new space coming on the market as well as space in existing properties, is seen at 32.2 million square feet this year and 46.1 million in 2014.

Industrial vacancies on the decline

Industrial vacancy rates are likely to fall from 9.2 percent in the fourth quarter of this year to 8.6 percent in the fourth quarter of 2014. Annual industrial rents are expected to rise 2.3 percent this year and 2.5 percent in 2014. Net absorption of industrial space nationally is anticipated at 97.0 million square feet in 2013 and 104.9 million next year.